Crop insurance: Private benefit, yet public impact

Crop insurance may be part of the permanent U.S. agricultural law that Congress will not delete in re-writing the farm bill, so plan for premium costs in your crop budget for next year. However, some of those premium costs could eventually climb higher if Congress directs the USDA’s Risk Management Agency to have farmers pay a larger share of the cost for the Harvest Price Option.

The HPO was an automatic part of crop insurance in 2012, unless a farmer decided to opt out of it for a lower premium cost. But the use of the Harvest Price Option raised the price guarantee on corn from $5.68 to $7.50 and on soybeans from $12.55 to $13.59 per bushel. As a result some of the higher coverage levels will return substantial indemnity payments to producers.

First, do you know what you will be getting for an indemnity payment, if you carried crop insurance through the 2012 drought? If you had revenue protection, Iowa State University ag economist Steven Johnson says multiply your APH yield by your coverage level to get your guarantee. Subtract your actual yield from the guarantee, and if it is lower, the remainder will be your loss per acre. If you had Revenue Protection, multiply the $7.50 Harvest Price by the loss to determine the amount of your indemnity payment per acre.

In his example, Johnson used a 175 APH, a 75 percent coverage level, and ended up with a 31.3 bushel per acre loss after deducting the 100 bushel per acre actual yield. By multiplying the 31.3 by the $7.50 price of corn, the net indemnity is $234.75 per acre. While 75 percent coverage is lower than many policies, it had a lesser premium cost. For producers willing to move toward an 85 percent coverage level, the producer in Johnson’s example would have received a $365.62 indemnity per acre. However, a producer which opted for only the spring guarantee at the 85 percent coverage level reduced his indemnity check to $276.90 per acre, a revenue reduction of $88.72 per acre.

While the Harvest Price Option returns more indemnity payment, it also costs more in premium payments. But the squawk about the harvest price option is coming from federal budget hawks who say the premium for the HPO should not be subsidized by the taxpayer, and should be borne by the producer.

Ohio State University ag economist Carl Zulauf says critics complain about the increased cost resulting from the HPO for 2012, particularly about the common coverage levels which allowed the insurance payment to exceed that for a farm only expecting to get the spring guarantee, and Zulauf should be asking the question of whether the principles behind the farm safety net is being violated, since a loss is shared between the farm and public, but now greater profitability is being guaranteed to the farm.

Zulauf makes the case that 85 percent coverage at the harvest price returned 112 percent of what was expected in the spring for corn, and 104 percent of what was expected in the spring for soybeans. His research report is focused on farmers who used the spring guarantee to forward contract their production. He demonstrates that pre-harvest sales usually occurred between 1974 and 2006, when farmers could be guaranteed of their crop insurance to cover any financial penalty for over-selling their production.

Zulauf observes that: “The harvest price option can result in a situation where a farm has more revenue at harvest than the revenue that was expected prior to planting, even after experiencing a decline in yield. This situation has occurred in 2012. Critics are asking whether this situation is fair and whether the definition of loss is appropriate.” He follows that up with another observation: “While underscoring the simplicity of this analysis, it suggests that offering the harvest price option on all insured production may lead farmers to sell more than is consistent with appropriate risk management.” In other words, Zulauf says critics are wondering if their tax money is subsidizing crop insurance that will allow farmers to sell more grain than they normally would, because they have the fall guarantee.

But how much is the public really underwriting the cost of crop insurance? Kansas State University ag economist Art Barnaby says the total amount is declining substantially, following the better than expected yields for soybeans that are being reported.

While one of his colleagues, Iowa State’s ag economist Bruce Babcock had predicted a $30-$40 billion dollar crop insurance payout earlier in the summer, Barnaby now estimates the underwriting loss to be in the $5-$6 billion range. The Standard Reinsurance Agreement between USDA and the crop insurance providers calls for different participation ratios between each one. While many of the companies will have a loss, he says some companies will actually have a gain in income this year, depending on the states they serve.

But Barnaby also reminds crop insurance critics of the money that crop insurance has generated for many years. While insurance companies can roll that into retained earnings and bolster their reserves, the government cannot claim a profit, even though it may not have paid out more than its premium income for many years. Although the crop insurance system is supposed to be set up to pay out the same amount it takes in, Barnaby uses Illinois as an example. He says, “For the 23 years prior to 2012, farmer paid premiums in Illinois on all crops and insurance contract types exceeded the claims, meaning in the aggregate, Illinois farmers netted none of the subsidy.

That was also nearly true for Iowa, but it is possible the 2012 underwriting losses may wipe out all of the underwriting gains (includes farmer paid and FCIC paid premiums) for the past 23 years in Illinois, i.e. Illinois farmers may net all 23 years of subsidy in 2012. This would require an Illinois loss ratio of 400 percent.”

Summary:

Crop insurance indemnity payments will soon be distributed based on crop yield loss and coverage level, with some farmers at high coverage levels receiving more than they expected at the level of the spring guarantees. The expectation of harvest price coverage may have caused more farmers to forward contract more grain than normal, had they not had the harvest price option. While the higher cost of the harvest price option may be shifted to farmers from the government during the next Farm Bill consideration, the actual amount of USDA payments to crop insurance policy holders may be lower than previously expected.